December 29, 2013 at 23:40Financing increases your risks
- Transfer
From a translator: CTO and cofounder of GrantTree and Woobius Daniel Tenner share their thoughts on attracting funding for start-ups. He claims that this greatly increases the risks, and I agree with him. In my opinion, beginning entrepreneurs need to go to business incubators and accelerators, but only in most cases they take projects with the expectation that they will immediately begin to attract additional venture capital investments after graduation. I think this is wrong. For example, I have a project that does not scale well and is not very attractive for an investor, but it already generates revenue. I am sure that I can earn and develop at the expense of my own turnover, why do I need investments then? Actually, the translation:
It's no secret that I like bootstrapping. It's nice to keep full control over the business, which I myself founded. There are some circumstances in which I would consider raising capital (as a bridgehead, not a pillow ) for the proper conduct of business, but I think that they are possible in a rather limited number of interesting (which are fun to manage) or almost interesting types of business and in quite an insignificant part of the business that beginners can do.
Nevertheless, I consider both methods - bootstrapping and raising capital - acceptable when building a business. It all depends on your goals and circumstances. Without raising capital, it would not have been possible to launch Google and achieve today's success. Facebook needed to get a share of the space of social networks first, and only then to make a profit, so financing is also needed here. Even Apple, the main money bag, required funding to start production (although today they probably would have used Kickstarter). Some types of business simply cannot exist without significant investment. Some work in a market where the winner receives everything, but financing is needed to win. And some just do not have a clear business model from the start.
Sometimes I talk with people about financing in the context of a business that should start making profits quite early or already bring decent amounts of money, and they say they are looking for financing to reduce their own risk. This is a terrible fallacy. Financing does not reduce your risks or the risks of your business - it increases them.
For example, the creation of a business worth 20 million pounds is a rather amazing achievement, but if you received 10 million from venture capitalists, with double pre-emptive rights, they will simply destroy you and leave you, as a founder, almost penniless. In such a scenario, the refusal of financing and the creation of a business worth 5 million pounds would bring the founder much more financial benefit.
Financial backers may be a little more lenient, but they tend to seek dividends, and using financing for the first time will gently push you towards bigger and bigger loans. Such financing does not necessarily divide the result into two parts (patrons are more liberal if you decide to just start your own business and pay dividends), but still the great success of the first business may seem like a failure.
Remember that venture capitalists, despite all the joyful articles, are not doing business to help you. They want to make money for themselves and their partners. Some follow a more ethical and conscious path than others, and this is commendable, but their main business model is to get a good return on a few super-investments and limit losses on “failures” as much as possible.
Financing is useful when you are prepared for additional risk in exchange for potentially greater profits. The concept of “startup lottery” is not so far from the truth. Investing is like gambling. When you use capital investments, you risk more, both yourself and on behalf of the company, in exchange for potentially greater benefits.
If there was a way to increase profits without increasing risk, everyone would use it (in fact, there are many similar ways, for example, the help of mentors, in-depth study of the topic, etc.).
From this point of view, it becomes obvious when financing is worth using: you have to take additional risk if you can afford it.
Most beginner founders are in straitened circumstances. Moreover, as newcomers, they already take a big risk because they don’t know how to manage any business, not to mention the mega-successful fast-growing technology startups. This is compared to those who, in the past, were able to launch and profit from a pair of traditional enterprises, and now are looking for new ideas. This experienced entrepreneur may take an additional risk to obtain much greater benefits than from his past ventures.
Given these circumstances, I want to say that new founders should try to reduce their risks, rather than increase them. It’s better for them to have a risk curve that gives a 30% chance of making more money than in the previous job, with a fairly smooth distribution of poor results and a low probability of zero profitability (which, in my opinion, is within reach) than such a curve, which gives a greater chance of zero profitability and a slightly increased probability of very large profits.
In short, novice founders should almost never raise funds.
It's no secret that I like bootstrapping. It's nice to keep full control over the business, which I myself founded. There are some circumstances in which I would consider raising capital (as a bridgehead, not a pillow ) for the proper conduct of business, but I think that they are possible in a rather limited number of interesting (which are fun to manage) or almost interesting types of business and in quite an insignificant part of the business that beginners can do.
Nevertheless, I consider both methods - bootstrapping and raising capital - acceptable when building a business. It all depends on your goals and circumstances. Without raising capital, it would not have been possible to launch Google and achieve today's success. Facebook needed to get a share of the space of social networks first, and only then to make a profit, so financing is also needed here. Even Apple, the main money bag, required funding to start production (although today they probably would have used Kickstarter). Some types of business simply cannot exist without significant investment. Some work in a market where the winner receives everything, but financing is needed to win. And some just do not have a clear business model from the start.
Sometimes I talk with people about financing in the context of a business that should start making profits quite early or already bring decent amounts of money, and they say they are looking for financing to reduce their own risk. This is a terrible fallacy. Financing does not reduce your risks or the risks of your business - it increases them.
Risk structure
Attracting financing divides all your possible results into two parts. Initially, a business can turn into anything, starting from a complete failure (with zero or even negative financial result) and ending with a resounding success, with all the intermediate values. If you attract financing, it destroys a number of intermediate options. Venture capitalists will certainly want dividends, and if they are too small, the entrepreneur's good success can turn into a relative failure.For example, the creation of a business worth 20 million pounds is a rather amazing achievement, but if you received 10 million from venture capitalists, with double pre-emptive rights, they will simply destroy you and leave you, as a founder, almost penniless. In such a scenario, the refusal of financing and the creation of a business worth 5 million pounds would bring the founder much more financial benefit.
Financial backers may be a little more lenient, but they tend to seek dividends, and using financing for the first time will gently push you towards bigger and bigger loans. Such financing does not necessarily divide the result into two parts (patrons are more liberal if you decide to just start your own business and pay dividends), but still the great success of the first business may seem like a failure.
Remember that venture capitalists, despite all the joyful articles, are not doing business to help you. They want to make money for themselves and their partners. Some follow a more ethical and conscious path than others, and this is commendable, but their main business model is to get a good return on a few super-investments and limit losses on “failures” as much as possible.
Easily…
If financing so increases risk, then why is it needed at all?Financing is useful when you are prepared for additional risk in exchange for potentially greater profits. The concept of “startup lottery” is not so far from the truth. Investing is like gambling. When you use capital investments, you risk more, both yourself and on behalf of the company, in exchange for potentially greater benefits.
If there was a way to increase profits without increasing risk, everyone would use it (in fact, there are many similar ways, for example, the help of mentors, in-depth study of the topic, etc.).
From this point of view, it becomes obvious when financing is worth using: you have to take additional risk if you can afford it.
Most beginner founders are in straitened circumstances. Moreover, as newcomers, they already take a big risk because they don’t know how to manage any business, not to mention the mega-successful fast-growing technology startups. This is compared to those who, in the past, were able to launch and profit from a pair of traditional enterprises, and now are looking for new ideas. This experienced entrepreneur may take an additional risk to obtain much greater benefits than from his past ventures.
Given these circumstances, I want to say that new founders should try to reduce their risks, rather than increase them. It’s better for them to have a risk curve that gives a 30% chance of making more money than in the previous job, with a fairly smooth distribution of poor results and a low probability of zero profitability (which, in my opinion, is within reach) than such a curve, which gives a greater chance of zero profitability and a slightly increased probability of very large profits.
In short, novice founders should almost never raise funds.